US banks gearing up for a consumer debt tsunami

The last few years for US banks have been a period of extraordinary turnaround, with some decent gains across the board since 2012 as the US economy came out of the financial crisis on the back of a restructuring of its banks, an improving economy and the slow normalisation of monetary policy by the US Federal Reserve.

To help complement the recovery in the share prices of various banks, we also saw businesses embark on huge buyback programmes, which also helped to juice share prices. Bank of America's share price recorded some of the best gains since the beginning of 2012.

US banks share price comparison since 2012

Source: CMC Markets

Some of this outperformance was down to the collapse in the Bank of America share price, given its role in the 2008 banking crisis, and its disastrous decision to purchase Countrywide, which then saw the share price plunge from levels above $50 a share to as low as $3 a share. It was a deal that cost the bank billions of US dollars in losses, fines and aggravation. As a result, it’s been a long road back for Bank of America and while the share price is still well below pre-crisis levels, shareholders have seen the benefits of dividends and buybacks in recent years.

Of all the US banks, only JPMorgan Chase has been able to recover the levels it was trading at prior to the financial crisis, trading at record highs just prior to the market crash in March 2008. None of the other banks have got anywhere close to it, and while Goldman Sachs has tried, it's not really a retail bank in the true sense of the word, which should insulate it to some extent from the tsunami of credit and loan loss defaults that many fear is about to ripple through US banking systems.

Wells Fargo, a less well-known US bank, is also an important bellwether of the US economy in its role as one of the biggest US mortgage and credit providers, which means it more than any other US bank is the most exposed to a cardiac arrest in the US economy.

The other better-known brands like Bank of America, Citigroup, Goldman Sachs, JP Morgan and Morgan Stanley have large investment banking divisions, which allow them to operate on an international scale and diversify their risk, thus making money in other areas.

With US stock markets rallying from their recent lows, the question being asked is whether the US banking sector can readily absorb the shock that is about to hit the US economy from the economic shutdown, caused by the spread of the coronavirus pandemic. The Federal Reserve has helped by allowing for the relaxation in capital buffers, while in the middle of last month the eight biggest US banks decided to suspend their buyback programs, in a move designed to shore up their balance sheets ahead of what is likely to be a pyroclastic flow of loan defaults in the coming weeks and months.

There does appear to be some concern amongst some Fed members about the capacity of US banks to absorb what might be coming their way after Neel Kashkari, the head of the Minneapolis Fed urged US banks to raise an extra $200bn in extra capital to help them through any upcoming disruption. While the thinking is sound, the reality is that this particular ship may have already sailed. It is highly unlikely any investor will feel compelled to put extra money into US banks at this moment in time, and that’s even before you consider the type of message any such action would send to the markets. It could be potentially interpreted as akin to firing a distress flare into the air.

In any case, collectively in 2019 we saw US banks buy back a total of $108bn of shares with Bank of America leading the way with $28.1bn. They were followed by Wells Fargo returning $24.15bn to shareholders, JPMorgan returning $24bn to shareholders, Citigroup returning $18.5bn, Morgan Stanley $5.95bn and Goldman Sachs $5.3bn.

These are no small sums of money, and offer a window into how well the sector has done over the past two years, however they also raise the question as to whether the banks should maybe have held on to slightly more capital in the good times as the sector battens down the hatches for what is to come.

This week we got an early indication as to how these banks feel the US economy might get hit in the weeks and months ahead. With unemployment set to bust through 10% at the next non-farm payrolls report, and an additional 20m people about to be made unemployed, we’ve seen all the big US banks start to take mitigating action to absorb the pain coming their way.

JPMorgan set aside $8bn in respect of loan loss provisions in its latest Q1 numbers, while Wells Fargo has set aside $4bn. Bank of America has set aside $3.6bn, while Citigroup has put aside an extra $5bn. Goldman Sachs, which doesn’t have a retail offering worthy of the name, also had a difficult quarter, largely down to setting aside $1bn to offset losses on debt and equity investments. With New York at the epicentre of the coronavirus outbreak, Bank of New York Mellon’s loan loss provision has also seen a big jump, up from $7m a year ago to $169m. Morgan Stanley today completed the pain train for US banks with loan loss provisions of $388m for this Q1.

It is to be hoped that these provisions will be enough on their own, however given how resilient the virus appears to be, these provisions could be the first of many for the US banking sector. The size of these provisions speaks to the fear that this crisis could get a lot worse before it gets better, a sentiment that appears to be shared by investors, with CMC's US Banks basket down over 35% since the beginning of the year.

US Banks share basket chart

Source: CMC Markets

Fortunately, most of the banks appear to be well capitalised and are profitable in the areas of investment banking, where we’ve seen heightened volatility boost both revenue and profit in the other profit centres of the business over the past 12 months. This is probably just as well, and also somewhat ironic that the trading desks that attracted the ire of US regulators and consumers over ten years ago, could now be the only profit centres keeping these banks afloat in the coming months. The ability of banks to spread the risk in their operations is going to be crucial in the coming months with the worry that the more US focussed banks could struggle if the US economy continues to sink, in the manner it has in the past few weeks

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